What Gifts are Excluded from Gift Tax? The Answer is Not Always Easy

 By Rose Wilson

The federal gift tax annual exclusion is an easy to use and often overlooked planning tool.  Gifts qualifying for gift tax annual exclusions are not subject to gift tax and do not trigger gift tax reporting obligations.  The gift tax annual exclusion amount is $13,000 per donee in 2012.  With this exclusion amount available, a married couple could give away as much as $26,000 per year to every child and grandchild of theirs, every year, with no gift tax liability or reporting obligations resulting from such gifts (note, however, that these gifts need not be made to a relative to qualify for the annual exclusion from gift tax).  If the annual gifts to any one individual exceeds $13,000, all gifts must be reported. The application of gift tax annual exclusions can result in significant tax savings, especially if utilized regularly over a number of years.

The annual gift tax exclusion is only available for gifts of present interests in property.  I.R.C. § 2503(b).  A present interest in property is “an unrestricted right to the immediate use, possession, or enjoyment of property or the income from property (such as a life estate or term certain).”  Treas. Reg. § 25.2503-3(b).  Any direct or indirect restriction on enjoyment of the transferred property can prevent the donor from using the benefit of annual exclusions.  Restrictions can be imposed in a number of ways, such as through written agreements governing the permissible uses of the property, state or federal laws governing the type of property given, or existing third party rights to the property.  Thus, the determination of whether a gift of property qualifies as a present interest depends on the legal rights and restrictions resulting from the nature of the property given and the method by which such property is transferred to the donee.  While this determination is relatively easy when the gift is an outright transfer of cash or publicly traded stocks, it can become quite difficult when more complicated property interests, such as gifts of closely held business interests, are involved.

The United States Tax Court recently analyzed a gift transaction involving gifts of interests in a closely held partnership.  In Estate of Wimmer v. Commissioner, T.C. Memo 2012-157, a married couple created a limited partnership and subsequently gave limited partnership interests to their children, grandchildren, and other relatives.  The couple made gifts of partnership interests over a period of years and claimed the benefit of annual gift tax exclusions against such gifts.  The IRS argued that the gifts did not qualify for gift tax exclusions because the partnership interests were restricted.

When gifts of partnership interests are concerned, the rights and restrictions affecting a donee’s use of the partnership interest or the income from the partnership is governed primarily by the partnership agreement and state law.  Therefore, the Tax Court in Wimmer examined the partnership agreement to determine if the donees’ rights to use, possess or enjoy the partnership interests or the income from the partnership were restricted by the agreement.  The Tax Court found that the donees’ right to use the partnership interests was restricted because the partnership agreement provided that a partner could not transfer his or her partnership interest without the prior written consent of the general partners and 70% in interest of the limited partners (with some exceptions for certain transfers to related parties).   However, the Tax Court found that the donees’ right to income from the partnership was not restricted by the partnership agreement or otherwise.  Accordingly, the Tax Court held that the gifts of limited partnership interests were not unduly restricted by the governing partnership agreement and therefore qualified for the annual gift tax exclusion.

Although the Wimmer case was favorable for the taxpayer involved, the case is an important reminder that the application of annual gift tax exclusions may be denied based on the facts and circumstances of a particular case.  Taxpayers who are concerned with the eligibility of a particular gift may be well advised to consult with legal counsel before claiming the benefit of gift tax annual exclusions.

Explore posts in the same categories: Annual Exclusion, Estate Planning, Estate Tax, Gift Taxes, Tax, Tax Returns, Wealth Planning

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